Total hours worked grew at an annual rate of 2.7 percent in September, suggesting an up-turn in GDP growth after the 2011 to 2015 slump.
Australia: Housing, Incomes & Growth
A quick snapshot of the Australian economy from the latest RBA chart pack.
Disposable income growth has declined to almost zero and consumption is likely to follow. Else Savings will be depleted.
Residential building approvals are slowing, most noticeably in apartments, reflecting an oversupply.
Housing loan approvals for owner-occupiers are rising, fueled no doubt by State first home-buyer incentives. States do not want the party, especially the flow from stamp duties, to end. But loan approvals for investors are topping after an APRA crackdown on investor mortgages, especially interest-only loans.
The ratio of household debt to disposable income is precarious, and growing worse with each passing year.
House price growth continues at close to 10% a year, fueled by rising debt. When we refer to the “housing bubble” it is really a debt bubble driving housing prices. If debt growth slows so will housing prices.
Declining business investment, as a percentage of GDP, warns of slowing economic growth in the years ahead. It is difficult, if not impossible, to achieve productivity growth without continuous new investment and technology improvement.
Yet declining corporate bond spreads show no sign of increased lending risk.
Declining disposable income and consumption growth mean that voters are unlikely to be happy come next election. With each party trying to ride the populist wave, responsible economic management has taken a back seat. Throw in a housing bubble and declining business investment and the glass looks more than half-empty.
Every great cause begins as a movement, becomes a business, and eventually degenerates into a racket.
~ Eric Hoffer
Australia: APRA capitulates to Big Four banks
From Clancy Yeates at The Age:
Quelling investor fears over moves to strengthen the financial system, the Australian Prudential Regulation Authority on Wednesday said major banks would have until 2020 to increase their levels of top-tier capital by about 1 percentage point, to 10.5 per cent.
The target was much more favourable to banks than some analyst predictions, with some bank watchers in recent months warning lenders may need to raise large amounts of equity or cut dividends to satisfy APRA’s long-running push for “unquestionably strong” banks.
Markets are now confident banks will hit APRA’s target, estimated to require about $8 billion in extra capital from the big four, through retained earnings or by selling new shares through their dividend reinvestment plans…..
“The scenario where banks had to raise significant capital appears to be off the table for now,” said managing partner at Arnhem Asset Management, Mark Nathan.
Mr Nathan said the banks’ highly prized dividends also looked “safer”, though were not likely to increase. National Australia Bank and Westpac in particular have high dividend payout ratios, which could put dividends at risk from other factors, such as a rise in bad debts……
APRA’s chair Wayne Byres said the changes could be achieved in an “orderly” way, and the new target would lower the need for any future taxpayer support for banks.
“APRA’s objective in establishing unquestionably strong capital requirements is to establish a banking system that can readily withstand periods of adversity without jeopardising its core function of financial intermediation for the Australian community,” he said.
APRA chairman Wayne Byres used the words “lower the need for any future taxpayer support.” Not “remove the need…..” That means banks are not “unquestionably strong” and taxpayers are still on the hook.
A capital ratio of 10.5% sounds reasonable but the devil is in the detail. Tier 1 Capital includes convertible (hybrid) debt and risk-weighted assets are a poor reflection of total credit exposure, including only that portion of assets that banks consider to be at risk.
Recent bailout experiences in Europe revealed regulators reluctant to convert hybrid capital, included in Tier 1, because of fears of panicking financial markets.
Take Commonwealth Bank (Capital Adequacy and Risks Disclosures as at 31 March 2017) as a local example.
The Tier 1 Capital Ratio is 11.6% while Common Equity Tier 1 Capital (CET1), ignoring hybrids, is more than 17% lower at 9.6%.
But CBA risk-weighted assets of $430 billion also significantly understate total credit exposure of $1,012 billion.
The real acid-test is the leverage ratio which compares CET1 to total credit exposure. For Commonwealth this works out at just over 4.0%. How can that be described as “unquestionably strong”?
Minneapolis Fed President Neel Kashkari conducted a study last year in the US and concluded that banks need a leverage ratio of at least 15% to avoid future bailouts. Even higher if they are considered too-big-to-fail.
3 Headwinds facing the ASX 200
The ASX 200 broke through stubborn resistance at 5800 but is struggling to reach 6000.
There are three headwinds that make me believe that the index will struggle to break 6000:
Shuttering of the motor industry
The last vehicles will roll off production lines in October this year. A 2016 study by Valadkhani & Smyth estimates the number of direct and indirect job losses at more than 20,000.
But this does not take into account the vacuum left by the loss of scientific, technology and engineering skills and the impact this will have on other industries.
…R&D-intensive manufacturing industries, such as the motor vehicle industry, play an important role in the process of technology diffusion. These findings are consistent with the argument in the Bracks report that R&D is a linchpin of the Australian automotive sector and that there are important knowledge spillovers to other industries.
Collapse of the housing bubble
An oversupply of apartments will lead to falling prices, with heavy discounting already evident in Melbourne as developers attempt to clear units. Bank lending will slow as prices fall and spillover into the broader housing market seems inevitable. Especially when:
- Current prices are supported by strong immigration flows which are bound to lead to a political backlash if not curtailed;
- The RBA is low on ammunition; and
- Australian households are leveraged to the eyeballs — the highest level of Debt to Disposable Income of any OECD nation.
Falling demand for iron ore & coal
China is headed for a contraction, with a sharp down-turn in growth of M1 money supply warning of tighter liquidity. Falling housing prices and record iron ore inventory levels are both likely to drive iron ore and coal prices lower.
Australia has survived the last decade on Mr Micawber style economic management, with something always turning up at just the right moment — like the massive 2009-2010 stimulus on the chart above — to rescue the economy from disaster. But sooner or later our luck will run out. As any trader will tell you: Hope isn’t a strategy.
“I have no doubt I shall, please Heaven, begin to be more beforehand with the world, and to live in a perfectly new manner, if — if, in short, anything turns up.”
~ Wilkins Micawber from David Copperfield by Charles Dickens
Seven Signs Australians Are Facing Economic Armageddon
Economics advisor John Adams warns that Australia faces “economic Armageddon” because of “significant structural imbalances” not seen since the lead up to the Great Depression in the 1920s.
Here are his seven signs:
Seven Signs Australians Are Facing Economic Armageddon
Sign 1: Record Australian Household Debt
According to the Reserve Bank of Australia, Australia’s household debt as a proportion of disposable income now stands at a record high of 187%.
The two closest episodes were the 1880s and the 1920s, which both preceded the only two economic depressions ever experienced in Australian history in 1890 and 1929.
Sign 2: Record Australian Net Foreign Debt
Australia’s net foreign debt now stands at more than $1 trillion and as a proportion of Gross Domestic Product was at a record high of 63.3% in June 2016.
This makes Australians much more vulnerable to international economic developments such as higher global interest rates, international financial crises or major government or corporate bankruptcies.
Sign 3: Record Low Interest rates
Australia has its lowest official interest rates on record with the Reserve Bank of Australia’s cash rate sitting at 1.5%. The current low rate of interest is not sustainable over the medium term and will inevitably rise.
Australians, particularly in Sydney and Melbourne, who have borrowed record amounts of money are very susceptible to higher interest rates.
4: Australian Housing Bubble
The expansion of credit by the Reserve Bank of Australia has been pumped into the Australian housing market over the past 25 years. Credit, which has been directed to Housing as a proportion of Australia’s GDP, has exploded from 21.07% in June 1991 to 95.06% in June 2016.
Over the same period, credit which has been directed at the business sector or to other personal expenses has remained relatively steady as a proportion of GDP.
5: Significant Increases in Global Debt
The General Manager of the Bank for International Settlements stated on 6 February 2017:
“Total debt in the global economy, including public debt, has increased significantly since the end of 2007 … Over the past 16 years, debt of governments, households and non-financial firms has risen by 63% in the United States, the euro area, Japan, the United Kingdom, Canada and Australia, 52% in the G20 and 85% in emerging economies. Heavy debt can only leave less room for manoeuvre in responding to future challenges.”
Sign 6: Major International Asset Bubbles
There are significant asset bubbles in bonds, stocks and real estate in major economies such as the United States and China, which has been fueled by the significant increases in global debt.For example, the Shiller PE Index in the United States which measures the price of a company’s stock relative to average earnings over the past 10 years is now at 28.85. This is the third highest recorded behind the Tech Bubble in 1999 and “Black Tuesday” in 1929.
Sign 7: Global Derivatives Bubble
According to the Bank for International Settlements, the value of the over the counter derivatives market (notional amounts outstanding) stood at US$544 trillion.
Much of these derivatives contracts are concentrated on the balance sheets of leading global financial and banking institutions such as Deutsche Bank. The concentration of complex derivative contracts on bank balance sheets poses significant risks to both individual institutions and the global financial system.
Veteran Investor Warren Buffet has repeatedly warned that derivatives are “financial weapons of mass destruction” and could pose as a “potential time bomb”.
Household debt is too high. Rising foreign debt and record low interest rates are fueling a housing bubble. Global debt is too high and rising, while stocks are over-priced. Throw in the global derivatives “bubble” with some truly terrifying numbers just to scare the punters out of their wits.
Nothing new here. Nothing to see. Move along now. The global economy is in good hands…..
Or is it? Aren’t these the same hands that created the current mess we are in?
John Adams is right to warn of the dangers which could have a truly apocalyptic effect, that makes the global financial crisis seem like a mild tremor in comparison.
Some of the risks may be overstated:
The derivatives “bubble” is probably the least of our worries as most of these positions offset each other, giving a net position a lot closer to zero.
Defensive stocks like Consumer Staples and Utilities are over-priced but there still appears to be value in growth stocks. And earnings are growing. So the stock “bubble” is not too alarming.
Global debt is too high but poses no immediate threat except to countries with USD-denominated debt — or Euro-denominated debt in the case of Greece, Italy, etc. — that cannot issue new currency to repay public debt (and inflate their way out of the problem).
But that still leaves four major risks that need to be addressed: Household debt, $1 Trillion foreign debt, record low interest rates and a housing bubble.
From Joe Hildebrand at News.com.au:
Mr Adams called on the RBA to take pre-emptive action by raising interest rates and said the government needed to rein in tax breaks like negative gearing as well as welfare payments.
This, he admitted, would result in “a mild controlled economic recession” but would stave off “uncontrolled devastating depression”.
The problem is that the Australian government appears to be dithering, with one eye on the next election. These are not issues you can “muddle through”.
If not addressed they could turn into the four horsemen of the apocalypse.
Intent as the enemy of truth | On Line Opinion
From Jennifer Marohasy:
When all 1,655 maximum temperature series for Australia are simply combined, and truncated to begin in 1910 the hottest years are 1980, 1914, 1919, 1915 and 1940.
…..Considering land temperature across Australia, 1914 was almost certainly the hottest year across southern Australia, and 1915 the hottest across northern Australia – or at least north-east Australia. But recent years come awfully close – because there has been an overall strong warming trend since at least 1960, albeit nothing catastrophic.
……there is compelling evidence that the Bureau of Meteorology remodels historical temperature data until it conforms to the human-caused global warming paradigm.
I would like to see more open debate around this issue rather than the typical “trust me I’m an expert” or “the science is settled” response.
Source: Intent as the enemy of truth – On Line Opinion – 9/1/2017
Australia: Say goodbye to growth
Business investment in Australia continues its sharp descent since the end of the mining boom, falling below 14% of GDP for the first time since the Dotcom crash.
Source: RBA Chart Pack
Apart from the expected “cliff” in Engineering, investment in Machinery and Equipment has fallen to record lows.
Source: RBA Chart Pack
Without investment, growth is likely to contract. The impact on Australian wages is an ominous warning.
Source: RBA Chart Pack
Australian democracy is in very serious jeopardy | Macrobusiness
By Houses and Holes on November 4, 2016:
Australian democracy is in very serious jeopardy. China is making great strides towards it and its intentions are not benevolent. It’s obvious in local, regional and global trends and if we do not do something soon to protect our freedoms they are going to be sold into the burgeoning Chinese empire, as well as political hegemony, by a corrupt oligarchy.
Some of you will tell me to take off my tin foil hat for writing this. To you I say ‘listen up’.
For the next few decades the global political economy will be a contest between post-cultural free moving capital and deeply cultural labour. This will mean ebbs and flows between investment and regulation in an overall trend towards de-globalisation.
As nation states rise from the past few decades of globalisation to protect their respective labour pools, there will be an increasing Balkanisation of trade and investment flows, particularly in terms of regions. One can foresee a time when a European trading bloc competes with American and Asian trading blocs as each’s respective hegemon – US, China and Germany – muscles out its sphere of influence.
In terms of the magnitude of these respective spheres, the biggest loser will be the United States as it is increasingly contested in North Asia. Europe may also lose as the eurozone either disintegrates or shrinks. China will win big.
Don’t get me wrong, I am not arguing that China will grow to rule the world, nor that the US will decline and fall. In fact, I expect US economic dominance to outlast China’s great leap forward owing to its immense sophistication, markets, research capability and excellent demographics. On the other hand, China faces an extremely difficult transition through the ‘middle income trap’ and terrible demographics.
Nonetheless, the sheer magnitude of these economies and powers mean that the great regional Balkanisation will transpire.
Thus Australia will find itself an object of contest within a region caught between respectively receding and advancing Super Powers. We are already seeing this very clearly in the shifts undertaken by both the Philippines and Malaysia. Both nations are led by highly dubious democratic leaders under intense pressure from a traditional US ally to come clean on corruption.
Yet both have instead turned to China to prop up their respective regimes with enormous investment deals that have come with fabulous reciprocal endorsements for Beijing, Manila and Kuala Lumpur. This while the US’s rather foolishly self-serving TPP dies on the shelf.
At the risk of stereotyping, these new Asian power relationships much more resemble a Confucian model that privileges patronage and filial bonds above the probity and meritocracy of democracy. China’s goals here are very obviously to undermine not just US influence but to empower local entities that are sympathetic to its interests. It may or not be an explicit goal to undermine democracies as well but if promoting local ‘strongmen’ does so then all the better!
Now turn to our local circumstances. Australia is the midst of a terms of trade boomlet engineered exclusively in Beijing. After decades of stupidly pro-cyclical policy-making Australia is now little more than a southern province of Chinese economic policy. With the flick of a pen in an obscure public service department, China delivers tens of billions to our shores in coal revenues and our monumental trade deficit evaporates overnight.
There is no other economy on earth that I know of that works with this dependence. We call it lucky. And it is. But it also comes with strings attached and they have been on display for a decade or more. Australian policy attitudes towards China have morphed steadily from a middle power engagement that included dialogues on human rights and democratic process to today’s pragmatic “do what you like boss” attitude.
I’m not writing to judge that. The kids of Tibet and Tienanmen are not Australian and there are limits to how much anyone can care about far flung folk. Especially when you’re offered a hundred billion dollar blindfold. Moreover, China needs Australian dirt to power its development so the power transmission is not all one way. The natural asymmetry of the political relationship is counter-balanced by the natural asymmetry of the economic one.
That’s the past. The future is very different indeed. China is going to need less and less dirt over time as it grows richer and more regionally powerful. And that’s where the recent events in the Philippines and Malaysia are a very important cautionary tale for Australian democracy. As we’ve seen, the next phase of Chinese development will be to throw off enormous sums of capital and people. Australia is happily gobbling up both at the moment to offset the declines in its dirt fortunes.
But this wave comes with much more explicit power compromises than we have already seen in action. The Sam Dastayari donations and rampaging property developer corruption scandals are the tip of the iceberg. Since then we’ve seen more and more Chinese bids for Australian strategic assets. This week we saw barely former trade minister Andrew Robb take a job advising the Landbridge Group, the owner of the Darwin Port. Landbridge is a shadowy firm involved in all sorts of stuff from chemicals to armed militias. It is widely considered to be beholden to Beijing in some way. At the very least the Darwin Port is the butt end of Beijing’s One Belt, One Road trade bloc monster. So here we have a trade minister out of the job for six months, a job that involved intimate consultation on the US’s competing regional trade deal, the TPP, tipping his intelligence directly into the Beijing trade bloc.
A less generous analyst might see this as some form of commercial treason. I will say that it is indicative of just how unprepared Australian parliaments are to address Chinese soft power influence in its manifold forms. Indeed, with the current crop of money-grubbing mock-libertarian ideologues in charge, we are a complete bloody pushover. Our checks and balances appear gossamer-thin in the executive. The intelligentsia is under assault from the Chinese student pipeline and pseudo-intellects like Bob Carr and his Chinese apologism. Nor can we rely on the media to hold any to account. Of the duopoly, Murdoch will give China the nod the moment the deal is good enough. Fairfax is dying and in its death throes has grabbed for a real estate lifeline that is itself China dependent.
It is not at all hard to imagine a circumstance like that that has engulfed the politics of the Philippines and Malaysia happening here. An Australian PM finds himself under siege and turns to Chinese patronage to bail him out. Explicitly or otherwise it will only take one desperate narcissist and Australia too will be welcomed into the waiting arms of Beijing patronage with all of its carrots and sticks determining precisely who wins and who loses Downunder. The following election would be fought between a candidate armed with hundreds of billions of dollars of firepower versus a guy promising recession.
So, I worry. I worry a lot, actually, that Australia is on the verge of giving away its most prized possession – its freedom – quietly in the dark for a few pieces of silver. To stop it we must move now, not tomorrow. We need:
- a big to cut the immigration intake and a rein the “citizenship exports sector”;
- an overhaul of the Chinese investment regime such that it be placed alongside the nation’s strategic objectives;
- a ban on foreign political donations (where is it?) and a Federal ICAC;
- a proper enforcement of rules governing foreign buying of real estate;
- a reboot of foreign policy that engages the US much more heavily in Asia.
Another couple of years of current policies and a few more Andrew Robbs and Aussie democracy as we know it is toast.
Reproduced with kind permission from Macrobusiness.
Beware of recency bias
Every the year the 2016 Russell Investments/ASX Long-term Investing Report provides an invaluable summary of before and after-tax returns on various asset classes for Australian investors, over 10 and 20 years.
Naive investors are likely to automatically pursue the asset classes that offer the highest yields. Recent performance is more likely to attract our attention than more stable longer-term performance. Josh Brown highlighted last year that mutual funds that attracted the most new investment tended to underperform funds that attracted the least new inflows. I suspect that the same applies to asset classes.
If we consider each of the asset classes highlighted, it is clear that performance over the next 10 years is likely to be substantially different from the last decade.
Source: 2016 Russell Investments/ASX Long-term Investing Report
Australian Shares
Australian Shares endured a (hopefully) once-in-a-lifetime financial crisis in 2008. 10-Year performance is going to look a lot different in two years time (20-years is 8.7% p.a.). Prices of Defensive stocks, on the other hand, have since been inflated by record low interest rates.
Residential Property
Residential property prices boomed on the back of low interest rates and an influx of offshore investors. But growth is now slowing.
Listed Property
REITS were smashed in 2008 (20-years is 7.7% p.a.). But before contrarians leap into this sector they should consider the impact of low interest rates, with many trading at substantial premiums to net asset value.
Bonds & Cash
Low interest rates again are likely to impact future returns.
Global Shares
Global Shares also weathered the 2008 financial crisis (20-year performance (unhedged) is 6.4% p.a.). Subsequent low interest rates had the greatest impact on Defensives, while Growth & Cyclicals trade at more conservative PEs.
I won’t go through the rest of the classes, but there doesn’t seem to be many attractive alternatives. It may be a case of settling for the cleanest dirty shirt, and the least smelly pair of socks, in the laundry basket.
Janet Yellen on financial market turmoil
Federal Reserve chair Janet Yellen before the House Financial Services Committee:
“…..As is always the case, the economic outlook is uncertain. Foreign economic
developments, in particular, pose risks to U.S. economic growth. Most notably,
although recent economic indicators do not suggest a sharp slowdown in
Chinese growth, declines in the foreign exchange value of the renminbi have
intensified uncertainty about China’s exchange rate policy and the prospects for
its economy.This uncertainty led to increased volatility in global financial markets and, against the
background of persistent weakness abroad, exacerbated concerns about the outlook for
global growth. These growth concerns, along with strong supply conditions and high
inventories, contributed to the recent fall in the prices of oil and other commodities. In
turn, low commodity prices could trigger financial stresses in commodity-exporting
economies, particularly in vulnerable emerging market economies, and for commodity-
producing firms in many countries. Should any of these downside risks materialize,
foreign activity and demand for U.S. exports could weaken and financial market
conditions could tighten further…..”
…No rate rises any time soon.